Economists ‘Cart Before The Horse’ Problem

Within this recent New
York Times article Fair Game - So Many Foreclosures, So
Little Logic , a report from the United States Comptroller
of the Currency, indicates that there is promising data
regarding loan modification trends in the United States.

However – research by Assistant Professor Alan M White
of the Law School at Valparaiso University, of 3.5 million
Sub Prime and Alt A Wells Fargo mortgages written between
2005 and 2007, seems to paint a different picture –
indicating that modifications are declining.

The
average monthly payment adjustment for modified mortgages
was found to be just $173. This would suggest the loan
modifications are a “sideshow” – at best.

In
June, the data show almost 32,000 liquidation sales: the
average loss on those was 64.7% of the average $223,000 loan
balance – or a loss of $144,000 each – up from 56.1%
loss of the loan balance last November and 63.3% in February
this year.

Belatedly – international discussion
is occurring of the New Zealand and Australia housing
markets and the Banking institutions ability to cope - refer
Analysis of Australian Bank Fundamentals -- Seeking
Alpha

Housing bubbles are a local issue - as
clearly illustrated by the Annual Demographia International
Housing Affordability Surveys (2009 5th Edition) of the 265
major urban markets of the 6 English speaking countries and
the Harvard University Median Multiple Tables.

The
latest Demographia Survey illustrates that of the September
Quarter last year, the Median Multiple nationally of the
major urban markets overall were – the United States 3.2;
Canada 3.5; United Kingdom 5.2; Ireland 5.4 with New Zealand
5.7 and Australia 6.0.

If housing exceeds three
times annual gross household income – it is in bubble
territory.

For example – housing prices bubbled
out to around 9 times annual household income in California
(the ‘epicenter of the Global Financial Crisis), while
there were no bubbles in Texas, where housing stayed at
around 2.5 times annual household income.

To
maintain market share – financial institutions mortgage
lending had to reflect the Median Multiples of the housing
markets they competed in.

The size and structures
of the mortgages simply had to reflect the Median Multiples
(house prices divided by the household incomes) supporting
them.

To illustrate – it would appear (from this
City Data - LA sample insured mortgages - refer bottom of
page) that average conventional insured mortgages in Los
Angeles during 2007 was $403,000 – with refinancing
mortgages around $430,000. Indeed - Herb Greenberg in
Mortgage Mess illustrates how lending in California
ballooned out to 11 times annual household earnings, where
for example those with a gross annual household income of
$90,000 were borrowing a million dollars.

It appears that financial institutions in
Australia are currently lending 5 to 7 times annual
household earnings and in New Zealand, in the order of 4 to
5 times annual household earnings. These are well above the
historical norm and current affordable markets, where
housing does not exceed 3.0 times household earnings,
requiring mortgage debt loads of around 2.5 times annual
household earnings.

To date – economists, property
commentators and the media generally have failed to ask two
extremely simple questions –

Firstly - why were
the sizes of the mortgages in Houston substantially lower
than they were in Los Angeles and other bubble markets
globally?

Secondly - what are the real costs and
consequences of lending in to housing markets, where there
are artificial regulatory scarcities in place, as a
necessary foundation for speculative bubble behavior to get
underway?

Put simply – they could not write
$400,000 mortgages on $150,000 houses in Houston.

Yet – too many economists “put the cart before the
horse” in suggesting the finance sector is responsible for
the housing bubbles in certain markets globally – when
this is clearly not correct. The finance sector simply
provided the debt finance “fuel” – investors and
speculators the rest with often ‘bubble equity”.

Clearly - Local Government failure put in place the
artificial scarcities, allowing speculative bubble behavior
to get underway.

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